Macro Talk – Donghai Zhang (University Pompeu Fabra)

Event details

Monetary policy shocks affect interest rates at long horizons (10 years or more). Furthermore, the private sector’s real GDP forecasts are revised upward in response to a monetary tightening. These facts challenge the prevailing theories in academic and policy circles, which are based on the paradigm that monetary policy has limited long-run effects and a monetary policy tightening should depress agents’ beliefs about real GDP. In this paper, I propose a micro-founded model to rationalize those facts, based on the information channel of monetary policy. I consider a framework where the central bank has private information about future economic conditions. Agents update their beliefs according to Bayes’ theorem. Policy actions play a signaling role, and may therefore have an impact on both short and long-term interest rates. Moreover, I provide novel empirical facts that the aforementioned responses are stronger when monetary shocks are expansionary. An extension of the model with ambiguity averse agents and ambiguous signals rationalizes such an asymmetry. Finally, I discuss the implications of information frictions for the design of optimal simple rule.